Investors can generate a return on their investment through capital gains, dividends or a combination of both. Quality dividend stocks typically provide investors with a return on investment any time the distribution arrives in the brokerage account of the shareholder. As a result, long-term investors typically look for quality dividend stocks as a way to generate returns which are not at the mercy of the stock market, but are rather directly linked to the actual financial performance of the corporation. Living off dividends is particularly important for investors who need income in retirement, and would not like to reduce the number of shares they own in order to maintain their lifestyle.
In order to generate a rising dividend income however, investors need to build a portfolio of carefully selected dividend stocks. Only after this has been accomplished, investors could sit back and get paid for waiting until the market realizes the value that shares are offering.
In my dividend investing, I focus on companies which are part of the dividend achievers and the dividend champions lists. I then apply my entry criteria in order to narrow down the list to a few candidates for further research. After that I look at the story behind the company and try to understand how it generates income. I look for companies whose products or services would still be used by consumers a few decades from now, and which have a strong competitive advantage over competitors. This wide moat would protect the business and build a strong foundation for future growth.
In addition, ensuring that the dividend is sustainable out of earnings and cash flows is essential for investors. This helps in maintaining stability of dividend income during recessions, as companies that have temporary dips in earnings would be less likely to cut dividends. In addition, companies with long histories of increasing dividends, would be less likely to cut distributions and enrage long term stockholders, unless the financial situation is dire. As a result, investors who live off dividends in retirement would not have to worry about market fluctuations. The regular dividend payments arriving in their brokerage accounts, like clockwork, would provide positive feedback that the companies they have invested in are still generating sufficient profits. As a result it does not really matter much to dividend investors if the market is down 20% or up 20% in a given year. As long as the underlying businesses of the carefully selected dividend paying stocks are still sound, then long term returns of share prices should be sufficient to at least match market returns.
The idea of relying solely on dividend income in retirement was tested for many retirees during the 2007- 2009 financial crisis. While many financial companies cut or eliminated their distributions, investors who held broadly diversified portfolios fared limited losses in income. During the darkest times, there were companies that still kept on raising distributions and extending streaks of consecutive dividend increases. Such companies included:
Kinder Morgan Energy Partners, L.P. (KMP) operates as a pipeline transportation and energy storage company in North America. The partnership distributed $3.39/unit in 2007, and then kept boosting distributions even throughout the crisis. The partnership distributed $4.58/unit in 2011. This MLP has raised distributions for 16 years in a row, and has a ten year distributions growth rate of 8.20%/year. Yield: 6.20%(analysis)
Wal-Mart Stores, Inc. (WMT) operates retail stores in various formats worldwide. The company paid $0.8275/share in 2007, and then kept boosting distributions during the financial crisis. The largest retailer in the world boosted dividends to $1.3975/share in 2011. The company has raised distributions for 38 years in a row, and has a ten year distributions growth rate of 17.90%/year. Yield: 2.10% (analysis)
McDonalds Corporation (MCD), together with its subsidiaries, franchises and operates McDonalds restaurants primarily in the United States, Europe, the Asia Pacific, the Middle East, and Africa. The company paid $1.50/share in 2007, and then kept boosting distributions. The fast food chain with the most recognizable brand in the world boosted dividends all the way to $2.53/share in 2011. The company has raised distributions for 35 years in a row, and has a ten year distributions growth rate of 27.40%/year. Yield: 3.10% (analysis)
Full Disclosure: Long MCD, WMT, KMP
- Dividend Investors – Do not forget about total returns
- Living off dividends in retirement
- Dividend Investors are getting paid for waiting
- Margin of Safety in Dividends
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